Shareholder Response to Research & Development Expenditure: A Study of Pharmaceutical Industry

What do the shareholders value more: the current profit or the future profit? We have tried to look into this classic issue in corporate finance in the context of pharmaceutical industry in India. If current profit prevails over the future profit, it would lead to profit maximizing behavior on the part of finance managers; if it is the other way round, it would lead to value maximizing behavior. Theory of financial economics accords value maximization as the right goal; however, the shareholder reaction may or may not be supporting it. Since the R&D expenditure reduces current profit, but has a potential for enhancing future profit, this study tries to measure its impact on shareholder value creation. The results indicate that companies engaging in R&D activity command higher valuations in terms of MV/BV ratio. The regression results indicate that MV/BV ratio is explained by Return on Equity (ROE) and R&D expenditure, with R&D expenditure having more weightage.